Understanding the Different Types of Student Loans
Understanding the different types of student loans is often the first test of higher education. Whether you're an aspiring student or a parent, knowing how to choose the right student loan will significantly impact your financial future. So let's get this study session started by examining public and private student loans and exploring their benefits and considerations.
While we’re at it, be sure to add credit union student loans to your crib sheet. They often have some of the most competitive rates available, so it is worth checking out your local credit union.
What Are Student Loans?
A student loan is money a lender gives you to pay for higher education costs with the agreement that you will pay the funds back with interest over time.
Different student loan providers offer various payment plans, interest rates, eligibility criteria, and other options. Understanding the different types of loans available can help you choose the loan or loans that best suit your needs.
Types of Student Loans
The easiest way to think about how student loans differ is by the source of the funds. The four types of student loans are:
- Government-issued federal student loans
- State-sponsored student loans
- Private loans from sources like traditional banks, credit unions, and online lenders
- Institutional loans offered by organizations such as your college or university
Here is a breakdown of the types of student loans.
Federal Student Loans
Federal student loans are the most common type of student loan and account for more than 93% of all student loan debt.
The application process for federal student loans begins with the Free Application for Federal Student Aid (FAFSA). The federal government, through the Department of Education, will evaluate your FAFSA information to determine if you qualify for a federal student loan.
The main types of federal student loans are:
- Direct Subsidized Loans
- Direct Unsubsidized Loans
- Direct PLUS Loans
Here are the fundamental differences between them.
Direct Subsidized Loans
Direct Subsidized Loans do not accrue interest while the student is enrolled in school at least half-time. This delay in interest can cut your total loan cost by thousands. However, Direct Subsidized Loans are only an option for undergraduate students who demonstrate financial need, and they limit how much you can borrow.
Direct Unsubsidized Loans
Direct Unsubsidized Loans accrue interest even while the student is actively enrolled in school and even if the borrower is on an income-driven or similar repayment plan. There are limits on how much you can borrow via unsubsidized loans. On the plus side, there are no income limits to qualify for these loans, and they’re available to both undergraduate and graduate students.
Many borrowers use a combination of subsidized and unsubsidized loans.
Direct PLUS Loans
Direct PLUS Loans come in two varieties: Parent PLUS loans and Graduate PLUS loans. The only significant difference is who is eligible to borrow. If you guessed parents and grad students, respectively, you get an A+. Neither loan has income limits to qualify, but they carry slightly higher interest rates than other federal loan options.
Pros and cons of federal student loans
Federal loans are often desirable because qualification is relatively easy, and the loans have low, fixed interest rates. Federal loans also offer several repayment plans, forbearance, or even forgiveness.
The downside of federal student loans is that they may not have the lowest interest rates, and there are limits on how much an individual can borrow. Some federal student loans also have income qualification limits.
Additionally, it's essential to know the number of loans you are eligible for may not come close to bridging the "tuition gap" — the money you have versus the cost of attending college. For that reason, many students and families with federal student loans also opt to use loans from other lenders.
State-Sponsored Student Loans
Uncle Sam isn’t the only government-based student loan lender. Every state offers some kind of student loan program.
To qualify for state student loans, you generally must either be a resident of the state or a non-resident enrolled at a school within the state. (If your educational plans cross state lines, it's worth evaluating the programs in both states.) Most states will also require you to fill out the FAFSA. But note that some state programs have earlier deadlines than the feds or make aid offers on a first-come, first-served basis. If you're considering state-sponsored loans, getting that FAFSA in as soon as possible is worth it to ensure you get your fair share.
There are some general similarities to all 50 state lending programs. Most of the loan options roughly mirror those available from the federal government. They may have different types of loans or loan terms for state residents versus out-of-state students. And because states have fewer resources than the feds, they may have higher interest rates or fees.
Private Student Loans
With private student loans, students and/or families apply to a private lender for the loan. Traditional banks, credit unions, and online lending platforms issue private loans. The federal government does not back them, and each has its qualification criteria.
Generally, you can use private loans to borrow up to the cost of attending your chosen institution, but some lenders may have lower borrowing limits. As for your interest rate, your credit score will play a critical role. Private lenders do sometimes offer discounts that amount to a slightly lower interest rate if you meet certain criteria such as setting up automatic bill pay or having other financial accounts (a credit card, savings account, etc.) with the lender.
If you apply to a bank or credit union for a private student loan, you'll need to provide certain information, such as:
- proof of citizenship or residency
- proof of enrollment
- your estimated financial aid
- the cost of attending your selected school
It's a good idea to compare loan amounts and interest rates from a few potential lenders to find the best terms for you. When you're ready to apply for a loan, the lender will run a hard credit check and, in most cases, approve the loan.
If you apply for a private student loan from an independent online lender, the process is pretty much the same, except you will not have the option of an in-person loan application. Before applying to an online lender, ensure it is a legitimate business to avoid scams.
Private loan consolidation
Private student loans can also be an option after graduation, a time when many look into loan consolidation. You can consolidate federal loans, private loans, or a mix of each, although not all loans can be consolidated.
What's the point of loan consolidation? The simple answer is getting loan terms that better fit your financial goals. Depending on your credit score, consolidating student loans can often lower your interest rate. In the long term, that can add up to huge savings. Or, if money is tight post-graduation, you can get a loan with a longer payment term to reduce your monthly payment. The downside is you'll end up paying more in interest over the life of the loan.
In either case, consolidation can eliminate at least one headache — you'll have fewer student loan accounts to monitor, so there is less chance of accidentally missing a payment.
Pros and cons of private student loans
Private student loans have much more variety and options than federal loans, so you'll need to do a little more shopping around to understand the different types of student loans available privately. You should also consider the pros and cons of private student loans.
While private loans can offer lower interest rates, they may also have higher origination fees or other costs. Private lenders will also require a student to have a cosigner if their credit is poor or even just too new, which is often the case with young students just entering college.
Another important consideration for private loans: Their repayment and forbearance options may be minimal or nonexistent. And private loans do not qualify for forgiveness unless the borrower dies or is permanently disabled.
Institutional Student Loans
The student's college or university sponsors institutional student loans. Generally, schools offer these loans to bridge the difference between a family's financial aid and the total cost of attendance. Other private organizations, such as trade groups or not-for-profits, may offer some institutional loans.
These loans vary widely in their terms, benefits, and eligibility. Some schools require a FAFSA; others have a separate application. They may have income limits, borrowing limits, or origination and other fees. Some schools offer subsidized loans; others have very high-interest rates.
If you qualify for an institutional loan, review the details carefully. They can be a great way to help finance higher education, but they may also offer suboptimal terms that negate the benefits of the loan.
How to Choose the Right Student Loan
There are a lot of factors to consider when deciding how to choose the right student loan. There isn’t one “best” type of loan. You’ll have to do your homework to weigh the benefits and downsides of your various federal, private, state, and institutional loan options.
Factors to consider in your analysis:
- Interest rates. Are they fixed or variable? Can you get a lower rate from a different lender?
- Fees and discounts. What is the origination fee? Does the lender charge any other fees? What about interest rate discounts?
- Repayment terms. How long do you have to pay it back? Does it accrue interest while the student is in school? Does it offer forbearance, income-based payment plans, etc.?
- What are your financial goals and expectations? Would you prefer to make larger monthly payments on a shorter-term loan? Or would it work better for you to pay less each month but for a longer period? Neither choice is right or wrong.
That said, there are some basic rules you can rely on as you evaluate your options. If you qualify for a Direct Subsidized Loan, take it. The savings on interest always makes it worthwhile. Just know that for most families, those loans aren’t nearly enough to cover the cost of tuition, room, and board.
Direct Unsubsidized Loans are the next best option for many families since they have low fixed rates and qualification is easy. The exception would be if the borrower (or their cosigner) has excellent credit and can get a lower interest rate with a private loan. Next, private and institutional loans should be considered using the same criteria to weigh how well the loans meet your needs.
Remember: Your financial needs, goals, and preferences are specific to you. A loan option that worked for a friend or family member may not be your best choice.
Credit Unions and Student Loans
Credit unions typically offer competitive interest rates, loan terms, rate discounts for auto-payments, and the extra support of having a local brick-and-mortar option if you ever need to talk to a real person about your loan instead of a chatbot.
Your local credit union can also help you weigh your loan options to decide which type of loan, in what amount, best suits your needs. Some credit unions even have online calculators that can help you estimate important details such as the anticipated cost of living, how interest rates will affect your total cost, and more.
Further Resources on Understanding the Different Types of Student Loans
There is much more to student loan options than we can fit here. For more information, check out the following:
- Go to the source. Federal Student Aid is the OG of financial aid information straight from the Department of Education. You can find more detail on many kinds of student loans as well as other financial aid here.
- Make comparisons. The Consumer Financial Protection Bureau site has tons of information to help you understand your offer of financial assistance, including loans, estimate what you'd still owe, compare offers from different schools, and more.
- Run different scenarios. Deep within the Federal Student Aid site is a loan simulator app that lets you calculate student loan payments under various repayment plans. You can also run the numbers to see if it's worth consolidating your loans.
Your Best Student Loan Options
There is no one way to choose the right student loan for you, and you'll probably need a combination of different loans to meet the cost of college fully. But you can feel more prepared by better understanding the different types of loans available to you.
Remember to check out credit union student loans, with their competitive rates, along the way. Our Credit Union Locator Tool can help you find a credit union near you.